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Zero candles policy

13 December 2011 By Martin Hutchinson

To celebrate Chairman Ben Bernanke’s birthday on Tuesday, the Fed gave the world no new stimulus. With U.S. unemployment down in November to 8.6 percent and fourth-quarter growth forecasts revised upwards, the central bank’s latest statement zeroed in on global problems, particularly in Europe. More notably, it didn’t introduce a “QE3” program of further Treasury bond purchases. Under such conditions, and with money supply strong, Bernanke’s gift of low rates to markets may expire by the time he turns 59 in December 2012.

Since Fed policy is exceptionally accommodating both in terms of interest rates and monetary stimulus, and the U.S. economy has shown significantly more robustness of late, the bank needed to find further justification for not tightening. The euro zone crisis provided it, along with slowing worldwide growth – though there was no hint of an early resort to further unmatched Treasury bond purchases, as some Fed watchers had expected. On the face of it, there should be little policy change before mid-2013, when the Fed’s commitment to near-zero rates expires.

Markets may force a rethink sooner than that, however. While consumer prices dipped in October, their 12-month rise is still 3.5 percent and oil prices are at nearly $100 a barrel. More ominously, M2 money growth was 9.8 percent in the last year, more than twice the four-quarter rate of growth in nominal GDP, suggesting inflationary pressures may be building.

The capital market distortion from heavily negative real interest rates is also more evident, producing increased risk of a “credit crunch” through capital misallocation. Thus, well before Bernanke blows out the candles again, the Fed may need to reverse course on rates, even if it also needs to provide yet more liquidity to the financial system after too many “gapping” games of borrowing short-term and buying long-term government-guaranteed bonds – instead of lending more to productive industry. That would be an unexpected, but welcome, present.


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